The impact of the Iran war has led to a steady rise in energy prices, exacerbating the inflation risks in the Eurozone. European Central Bank President Lagarde stated that they will adjust the inflation outlook. As a result, the probability of a rate hike by the European Central Bank in June has significantly increased. However, economists argue that raising interest rates is a mistake and could potentially lead to a recession in the European economy.
On May 25, European Central Bank President Christine Lagarde shared information on the X platform, where she participated in the “Che Tempo Che Fa” program to discuss European and economic issues.
Lagarde mentioned that when the ECB officials convene next month, they will adjust the inflation outlook. The March forecast predicted a 2.6% increase in prices for this year, a figure that “may be adjusted” as she noted changes in the situation since March.
In addition to Lagarde, European Central Bank Executive Board member Alexander Demarco recently suggested that the 2.6% inflation forecast was too optimistic and was released shortly after the outbreak of the Iran war.
Regarding the ECB’s upward revision of the inflation outlook, the host of the “Che Tempo Che Fa” program questioned whether this would prompt the ECB to hike interest rates on June 11.
Lagarde declined to provide further clarification, stating, “The current situation is highly uncertain, and we must examine all available data, evaluate the future economic trends over the coming quarters, assess the need for action, and analyze its impact on the medium term. Our goal is to maintain the medium-term inflation rate at 2%.”
Some economists and investors have predicted that the ECB will increase rates by 0.25 percentage points.
Lagarde’s colleagues also hinted that a rate hike may be inevitable. Yannis Stournaras, member of the ECB’s Governing Council and Governor of the Bank of Greece, emphasized that the ECB must avoid adopting overly restrictive measures to prevent further burden on economic activity and investment. He suggested that measures taken to address inflation should be balanced if it temporarily exceeds the target.
During the last interest rate decision meeting, ECB policymakers discussed the possibility of raising rates. Stournaras believes that the current approach should involve a cautious adjustment of monetary policy towards a more restrictive direction, balancing the suppression of secondary effects while avoiding disproportionate impacts on economic activity.
Stournaras stated last week that maintaining the ECB’s credibility is a strong argument supporting the rate hike on June 11.
However, Holger Schmieding, Chief Economist at Berenberg Bank in Germany, warned that in the backdrop of slowing economic growth and weakening demand in Europe, an ECB rate hike could further exacerbate economic pressures and potentially push Europe into a recession.
Schmieding, speaking on CNBC Europe’s morning financial program “Europe Early Edition,” pointed out that major European economies such as Germany, France, and Italy have already been impacted by soaring energy costs, leading to a stagnant inflation environment in Europe.
He believes that the latest Purchasing Managers’ Index (PMI) data has shown weakening momentum in employment and demand, and the Demand Destruction mechanism is expected to naturally curb inflation. With household spending shifting more towards energy costs, other consumption is likely to decrease, making aggressive rate hikes unnecessary. “It is important to differentiate between actions the central bank may take and what the correct course of action should be.”
Schmieding warned that “if the ECB continues to raise rates subsequently, Europe may not just face stagnant inflation but could potentially slip into a mild recession.”
During the April 30 meeting, the ECB kept the main deposit rate unchanged at 2%, but the decision statement indicated that the risks of upward inflation and downward economic growth have both increased.
Data shows that the Eurozone’s inflation rate rose to 3% in April, reaching a new high since September 2023, significantly surpassing the ECB’s 2% target.